October 26, 2018

October 26, 2018

26th October 2018

Oil Drilling Activity

Onshore US drilling activity increased by 2 with a total active count of 1046 rigs; those targeting oil increased 2, with the total at 875. Across the three major unconventional oil basins, the oil rig count increased 3 and stands at 614, with Permian down 1, Eagle Ford flat and Williston up 4.  

Sources: EIA Weekly Update and GCA Analysis

EIA reported last week’s total US domestic crude output at 10.9 million barrels, flat for the past week. The reduced production is linked to residual impacts of Hurricane Michael, which briefly shut-in over 0.6 million barrels a day during early October, though most operations were up and running within a week. US crude situation was dominated by a jump in oil inventories (+6.3 million Bbl) due to US refinery runs remaining low due to seasonal maintenance.

A rise in interest rates strengthens the U.S. dollar, the main currency used in oil trading, making oil more expensive for traders using other currencies. Fed officials raised their benchmark federal-funds rate a quarter percentage point last month to between 2% and 2.25%. They signaled that they expect to raise it again this year, likely in December, and penciled in around three increases next year.

Natural Gas – Ship owners long wait is over

Three years ago, owners of LNG carriers not operating under a long-term charter were bemoaning a very lack luster Q4 2015, with spot charter rates having fallen from a high of around US$150,000 per day, in mid-2012, to only US$30,000 per day.  Traditional, more fuel hungry steam propulsion vessels were making even less, rendering some of those vessels little more than scrap value. Not only that, but LNG traders were able to secure one-way only charters, leaving vessels unfunded for their ballast journeys or relocation.  However, signs of a recovery started to become apparent a little over a year ago when Asian LNG demand started to pick up, and both LNG spot prices and freight rates started to increase, especially for China deliveries.

Now, as we embark on Q4 2018, it appears that any slackness in the shipping market has been effectively eliminated and, in the last few weeks, we have seen charter rates roar through the US$100,000/day mark and hit rates near to US$150,000/day equivalent to the peaks of 2012.

To provide some idea of what that means, in terms of the price arbitrage traders would need to see to make deliveries worthwhile, it is helpful to look at how long it takes to deliver gas.  For example, the voyage from the US Gulf Coast to China is a distance of some 10,000 miles (through the Panama Canal).  For a modern LNG carrier, that equates to a round trip of some 45 days, including the time needed to load and unload the vessel.  By contrast, European deliveries only require around 24 days per delivery, and do not generate any canal fees.  Taking into account fuel, other costs and the canal, then at a US$150,000-day rate they would need an extra US$1.60 per MMBtu to make it worth their while to deliver to China instead of Europe.  This compares to an arbitrage of only 90c/MMBtu needed to incentivize traders to take LNG the longer distance to Asia when charter rates hit their lowest levels.

With the NBP/JKM basis differential currently trading at barely that level, it is not surprising that LNG traffic patterns are changing.  With the first ever cargo of non-Qatari gas (actually from the US) scheduled for arrival at the South Hook terminal in Britain, we see yet another example of how LNG is following other liquidly traded commodities.  It should not be a surprise that the LNG is simply following the money, but it has not always been like that.  These changes in global LNG patterns are showing yet again that the sector is becoming much more versatile and nimble, and the “stickiness” that used to be such a constraint on LNG trades is starting to evaporate ... a bit like the boil-off from an anchored carrier.

Crude Oil – Shifting to an oversupply

Oil prices stabilized, bouncing back from an early sell-off after Asian and European stock markets plunged in the wake of Wall Street’s biggest daily decline since 2011. US commercial crude stocks rose for a fifth consecutive week last week, increasing 6.3 million barrels to 422.79 million barrels. The market in the fourth quarter could be shifting towards an oversupply situation as evidenced by rising inventories over the past few weeks.

Brent crude, the global benchmark, has lost more than US$10 a barrel since hitting a high in October. Fear and anxiety about the global economy are currently playing a bigger role in the oil price than the actual fundamentals of supply and demand. The global economic outlook is deteriorating, with a broad range of asset prices and real-time economic indicators pointing to a slowdown in growth in 2019.

Financial markets have been hit hard by a range of worries, including the US-China trade war, a rout in emerging market currencies, rising borrowing costs and bond yields, as well as economic concerns in Italy. The combination of rising interest rates, a flattening yield curve, falling share prices and a strengthening dollar represents a significant tightening of financial conditions, not just in the US but around the world.

The May 2018 announcement that the US would reinstate sanctions against Iran included two wind-down periods, the second of which will end November 4. The effects of sanctions will increase during the first few months of full implementation and it is expected that Iran’s average crude oil production (excluding condensate) in 2019 will fall by approximately 1.0 million barrels per day from Iran’s April 2018 production level of 3.8 million barrels per day.

This decline is similar to the drop in Iran’s crude oil production that occurred when sanctions on Iran’s Central Bank were imposed in 2012.

The exact effect of the sanctions will depend on the total volume of crude oil and condensate that comes off the market and the response from OPEC members and other countries. EIA forecasts that OPEC spare production capacity will average 1.6 million barrels per day in 2018 and will fall to 1.3 million barrels per day in 2019, down from 2.1 million barrels per day in 2017 and lower than the 10-year (2008–2017) average of 2.3 million barrels per day.

This decline creates a market with relatively low spare capacity at the same time Iran and Venezuela are forecast to experience production declines.  In response, Saudi Arabia has signaled its willingness to release shut-in capacity in the short term and indicated a willingness to boost long-term capacity to 13 million barrels per day with investments of a further US$20 Billion. 

A largely flat Brent forward curve into first half 2019 suggests traders are unclear which way the next move in oil prices will be following the sharp recent correction.

Weekly Recap

Drilling Activity

Source: BHGE Rotary Rig Count

Total US rig count (including the Gulf of Mexico) stands at 1068, up 1 this week. The horizontal rig count stands at 927, up 1 this week. US rig activity continued to show constrained growth for 21 of the last 23 weeks and stands 17% above last year’s total.

High spec US onshore rig rates were rising in the first half of this year, but that may have leveled off during the 3rd quarter.  By contrast, offshore rig rates have been in decline for most of the last 4 years+, a trend that appears to have flattened off in response to both industry consolidation and scraping of older vessels plus improving development economics at higher oil prices.

A series of Final Investment Decisions for offshore projects in the coming months should see a development led boost to rig demand with project developers “locking in” current rig rates on multi-year contracts.  Utilization rates offshore are still mostly in the 40-60% range by market segment, thus day rate improvements may be modest, albeit welcome to a very hard-pressed sector of the industry.

Crude Oil Price

Brent, the global benchmark for oil, decreased US$3.62 to US$76.48 a barrel, reflecting a loss of 4.52% on the week.

WTI crude fell US$2.36 to US$66.80 a barrel, down 3.41% on the week.

US Crude Oil Supply and Demand

Sources: EIA Weekly Update and GCA Analysis

US crude oil refinery inputs averaged 16.3 million barrels per day, with refineries at 89.2% of their operating capacity last week. This is 48,000 barrels per day less than the previous week’s average.

US gasoline demand over the past four weeks was at 9.2 million barrels, down 1.3% from a year ago. Total commercial petroleum inventories decreased by 8.0 million barrels last week.

US crude imports averaged 7.7 million barrels per day last week, up by 63,000 barrels per day from the previous week. Over the past four weeks, crude oil imports averaged 7.7 million barrels per day, 0.7% more than the same four-week period last year.

US crude exports averaged 2.18 million barrels per day last week, an increase of 398,000 barrels per day from the previous week. Over the last four weeks, crude oil exports averaged 2.065 million barrels per day, 18% more than the same four-week period last year.

Crude oil inventories increased 6.3 million barrels from the previous week. The crude stored at Cushing (the main price point for WTI) increased 1.4 million barrels; total stored is 30 million barrels (~33% utilization).

   

Authors

October 26, 2018

P. Kevin Galvin

Principal Advisor - Sr. Manager Facilities/Cost Engineering Advisor - kevin.galvin@gaffney-cline.com
October 26, 2018

Nick Fulford

Global Head of Gas and LNG - nick.fulford@gaffney-cline.com

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